The New Institutional Economics: The NIC

1. The New Institutional Economics: The NIC Arto Lahti

2. Why the history of IPRs is relevant? The New Institutional Economics (NIC) • The New Institutional Economics attempts to incorporate a theory of institutions into economics. • It was Ronald Coase, a Nobel prize-winner, who made the connection between institutions, transaction costs and the neo-classical theory. • Institutions are formed to reduce uncertainty in many kinds of human exchange. Institutions are usually not necessarily created intentionally by governments or some other powerful actors of a society. • Institutions are patterns acquired from others which guide individual actions. Institutions economize on the scare resource of cognition, by providing us with ready-made anchors of sense or premises to decisions Coase, Ronald (1937) The Nature of the Firm, Economica, pp. 386-405. Coase, Ronald (1987) The Nature of the Firm, in Putterman, Louis, The Economic Nature of the Firm, Cambridge University Press, Cambridge.

3. Institutional environment as a cluster element, part of agglomeration economics • Douglass North, a Nobel prize-winner, focused on the institutional aspects of the economic past, concluding that economic institutions are path-dependent. Economic institutions are a market structure element. Theyexist because of network externalities, economies of scope, and complementarities. • Douglass North (1993) has claimed that institutions which protect property rights and lower transaction costs are the most decisive to the economic growth. • According to North’s thinking, the state can never be treated as an exogenous actor, since the state has the mandate to a set of property rights and to enforce competitive market conditions. North, Douglass (1993) Institutions, Institutional Change and Economic Performance, Cambridge University Press, Cambridge).

4. The neoclassical economics relies on competition. The NIC includes transaction costs. • Monopoly profits induce entry into the industry. The entry of new firms provides an equilibrating function in the market to restore prices and profits to the competitive level. • Coase explains the firm size through its efficiency in market transactions. A firm with a hierarchy is, thus, an alternative to the market mechanism. What are the comparative (transaction) costs is the question which Coase never answered. The Coasian transaction cost theory has remained abstract although the relevance of the theory is evident, if we assume like Chamberlin that markets are both competitive and monopolistic. • Coase includes the ex-ante costs of transacting following the idea of the mainstream economics. Oliver Williamsonincludes also expost costs of transacting.This extended cost concept is useful, since an ex-post contractual failure is salient when transactions are significant because of the asset specificity of a firmor because of the human nature. • Williamson follows the idea of agency theory that human behavior is not rational. Bounded rationality, moral hazards and risk awareness characterize human behavior more than assumptions of the perfect rationality. Williamson, Oliver E. (1985) The Economic Organization Firms, Markets and Policy Control, Harvester Wheatsheaf Books, New York.

5. The firm as the governance structure or nexus of contracts vs. production unit • Coase and Williamson define the firm as the governance structure or nexus of contracts, a view that contrasts with the mainstream theory of the firm. • The firm exists (in a certain size) if the use of market coordination via price mechanism is more costly due to ex ante transaction costs (e.g. bargaining of a contract) and ex post transaction costs (e.g. safeguarding an investment) than coordination via a firm. • Marks Casson provides a rationale to explain why MNCs internalize international operations rather than rely on the market mechanism. In terms of the modern IO-theory, an explanation to internalization is mobility barriers in the markets that a decision-maker cannot know ex ante, although could have the best possible information to be used (Robert Lucas). For instance, the complexity of local institutions, like business culture, is possible to perceive only ex post. • Ex post transaction costs can be expressed by the concept of business distance (Luostarinen, 1979), which means grouping the target countries according to the expectations of ex ante and ex post transaction costs. Williamson, Oliver (1990) The Firm as a Nexus of Trieties: An Introduction, in M. Aoki, B. Gustafsson, and O. Williamson (eds.), The Firm as a Nexus of Treaties, Sage Publications, pp. 1-25.

6. Oliver Williamson: Efficient governance structure • As Williamson emphasizes, the usual strategic preference for any kind of integration or internalizing is reversed by the transaction cost economics approach. Williamson’s advice is: • Vertical integration is the organization form not of first but of last resort - to be adapted when everything else fails. Try markets, try long-term contracts and other hybrid modes, and revert to hierarchy only for compelling reasons. • The basic notion of the transaction cost theory is that properties of the transaction determine the efficient governance structure. In figure 34 there is a relation between various governance mechanisms that an economic agent has in his mind: • Markets (M) • Hybrid (X) • Hierarchy (H) Williamson, Oliver E. (1991) Strategizing, Economizing, and Economic Organization, Strategic Management Journal, Vol. 12, pp. 75-94.

7. Williamsons’ transaction cost economics

8. What are the properties of the transactions that determine the efficient governance structure in the global markets? • Theoretically, there are many variations. It is only possible to demonstrate one set of properties what Williamson (1991) refers to. It is the complexity of transactions that can depend on the asset specificityor the human nature and many other things. In relation to complexity (k) these governance mechanisms have three different governance modes with different transaction costs: • Try market first means that markets as a governance mode have inherently low transaction costs, but in any case when markets can be efficiently used, the complexity should be low. An example of that are stock markets. • Hierarchy, to hire own employees, is the dominant alternative when complexity is high. An example is a FDI. • Hybrid, that means alliances, networks, etc. are in in-between and the most efficient choice when complexity is medium.

9. Hybrid forms of contracting • Hybrid forms of contracting have been popular in international trade. Examples of hybrid operations are: Licensing, franchising, contract manufacturing, turnkey, and co-production. Luostarinen (1979) calls these sorts of hybrid operatrions into Non-direct investment production operations (NIPOS). • One of the major reasons is time to markets as the primary measure of ex post efficiency of governance. The popular operation forms of the hybrid type are subcontracting and contract manufacturing that as an application of long-term contracting make intra-industry business processes more flexible than integration or internationalization. • Williamson’s view is especially relevant to knowledge-intensive services that are embedded in many networks and that are supposed to be both competitive and complex to economize. • Firms organize contractual function primarily in order to decrease the uncertainty (Knight) of complex transactions where they need the internal depth of institutional knowledge and matching of business and legal processes.

10. Torger Reve: The firm as a nexus of contracts (background) • Torger Revemakes an effort to combine the transaction theory of Williamson (1985) and the agency theory, and some contract ideas from sociology and law. Adopting the Coasian definition of the firm as a nexus of contracts, Reve defines a firm in an elegant way. • Referring to the notion of extended competition of Michael Porter (1980), Reve specifies the strategic core and four types of alliances in figure 36. Reve points out decision-maker’s ability to identify the comparative governance costs of markets, alliances and hierarchies. Reve provides an elegant solution to the crucial problem of the business definition, the firm’s borderlines in its environment. Reve, Torger (1990) “The Firm as a Nexus of Internal and External Contracts”, in M. Aoki, B. Gustafsson, and O. Williamson (eds.), The Firm as a Nexus of Treaties, Sage Publications. Eisenhardt, Kathleen (1989) 'Agency Theory: An Assessment and Review, Acade­my of management review, Vol. 14, No.1, pp. 57-74. Abell, Derek E. (1980) Defining the Business: The Starting Point of Strategic Planning, Prentice-Hall, Inc., Englewood Cliffs, New Jersey.

11. Torger Reve: The firm as a nexus of contracts (model)

12. Torger Reve: The firm as a nexus of contracts (model elements) • In Reve’s thinking a business (or a firm) can be defined to include two of the Coasian governance modes: • Strategic core or core competence Some of the competencies of a firm are core competencies and, thereby, belong to the strategic core. Prahalad and Hamel have stated that strategic thinking needs to be a core competency of a firm. In many cases, intellectual property is of that kind. • Strategic alliances Outside the defined business model and outside the firm’s borderlines are where, of course, a firm may have many kinds of economies of externalities in terms of Alfred Marshall and his followers. They can be called strategic alliances or networks • Market(s) It is evident that the concept of a market plays a critical role as a governance model since it its is the arena of competition Prahalad, Coimbatore K. and Hamel, Gary (1990) “The Core Competence of the Corporati­on”, Harvard Business Review, 68, 3, pp. 79-91.

13. Towards Network Organization

14. One important practical implication in Alfred Chandler’ writings is that he is convinced that the hated U.S. trusts of the late 19 century were the ones that succeeded to increase output, lower costs, and compete vigorously. This is an example of the fact that the evolutions of organization economics and economic institutions are parallel. • Globalization and the digital economy have challenged the doctrine of vertical integration. Middle-management has lost its position in industrial firms because of automation of firm’s production processes. The transformation from the vertically integratedorganizations to networking has enhanced flexibility without loosing control. • In the context of global markets, networking combined with digitalization, have made relocation possible as well as restructuring of production by changing the value of time. Networking is not a super highway for SMEs to globalize as the neo-Schumpeterian writers (Toffler, Naisbitt, Peters, etc) claimed from the 60s to 80s. Networking has been extremely useful for MNCs. In the industrial markets, the face-to-face interactions are potential economies of scope of SMEs. • Networking, the cooperative international operations, such as joint ventures or industrial franchising or licensing can be considered as ones that accumulates social or trust capital for entrepreneurs without hazarding the cash flow.

15. Accumulation of intangible and tangible capital • In order to create networks, we need a model that includes the model concepts of capital. It’s not so important what form of capital is included. There are three basically different kinds of capital: • Social (or Trust) capital • Knowledge (and Technology) capital • Money capital • Figure shows a model by professor Lahti where there are three basically different kinds of capital:

16. The Competition Policy of the nation reflects the philosophical mindset of the nation with regard to the organization of its economy. • A sovereign nation’s welfare is inextricably linked to the efficiency of its Competition Policy. So do the EU as an IIGO (International Governmental Organization). It is this that will determine the extent to which the economy will produce the goods in sufficient quantities and varieties to satisfy the needs of the public. • A nation’s competition law may be defined as legislation, judicial decisions, and regulations specifically aimed at avoiding the concentration and abuse of market power on the part of private firms, which could use that power to exclude potential competitors. • Experience in a number of jurisdictions has shown, that in protecting locally-based firms from foreign competition, competition in the local market for the respective good is likely to be destroyed. This highlights the fact that a nation’s international trade policy and competition law could be in conflict.

17. Competition Policy is implemented using various statutes and regulations . • Three vital components of the policy are • International trade policy which reflects the nation’s attitude toward goods which are traded across national borders; • Competition law which reflects that nation’s general attitude toward markets for goods which are traded within its borders. Competition law tends to protect the process of competition in the market. Since each component is implemented with distinct objectives, it is inevitable that conflicts arise from time to time; and • Sector regulations which reflect the nation’s attitude toward specific industries in the economy. Although each component is implemented under a common umbrella of competition policy, each has distinct objectives or purposes. International trade policies are invariably implemented to protect or shield locally-based firms from competition from foreign based firms. Sector regulations tend to protect firms currently operating within an industry from competing with each other, or from competing with firms desirous of entering that regulated industry.

18. The WTO (World Trade Organization)and the new economic order • Globalization is a multifaceted concept. It should, therefore, be put into a specific context in order to make sense. The most debated symbol of globalization is the WTO (World Trade Organization). The WTO treaty signed in the year 1994 deals with the rules of trade between nations at a global level and makes all member nation states equal. • Non-discrimination is the main principle on which the rules of the multilateral trading system are founded. WTO principles open up new business perspectives. This entails to look how trends across the globe, in markets, in politics, and new technology affect the globalization as a process. The challenge is international politics. • The WTO treaty has neoliberalism as the dominant doctrine of market exchange. The advantages of neo-liberalism are largely accepted. Among the positive results of the applications of neo-liberalism are privatization of state-own firms and more open market processes. The Among the negative results of the applications of neo-liberalism is the ongoing financial crisis.

19. Globalization enables firms global geographical reach in trade, investments, and competition • Globalization in this form is driven by the advances of information technology (IT) that makes it easy to maintain a global, real-time information exchange. The commercial media are expected to be the winner of the global geographical reach. Concepts like eCommerce or mCommerce contain expectations of much more. One example of that is Linus Torvalds, the famous Nordic actor, who has opened many windows of opportunities for the so-called open-source software. • The growth of transnational organizations of states, such as the EU will play decisive role in solving conflicts between national identities/ policies and the evolving global economy. To certain extent, the global super-cultures exist. Businessmen, politicians, scientists, pop-stars and students are examples of groups of people that are global in their minds. • Multiculturalism can be a strong asset for MNCs. For instance, Nokia’s slogan “connecting people” and behavior expose what the multiculturalism is about at the best. Karliner, Joshua (1997) The Corporat Planet, Sierra Club Book. Korten, David (1995) When Corporations Rule the World, London.

20. Kenechi Ohmae: The new regional division of labour in the global economy. • Since the 1960s, economists used to look at the division of labour as a North-South divide in the world economy. After the oil crisis in the early 1970s, the two-poles-model of the world economy has not been valid. • The New Industrialized Countries (NICs) and the Oil-Rich countries have emerged as in-between blocks. In the 1990s, the new entrants, China, India and the Asian Tigers emerged in the world economy. The historical North-South divide with the dominance of the U.S and the EU was over. The new entrants have even become competitors for Western MNCs. • The Chinese and Indian MNCs have started to utilize the same advantages that Western MNCs have found in China and India for their FDIs. Many developing countries in Asia (Indonesia, Malaysia and Thailand) and Latin America (Brazil, Chile and Mexico) have successfully opened up their economies under outward-oriented policies. Ohmae, Kenichi (1996) The Evolving Global Economy, A Harvard Business Re­view Book, Cam­bridge, MA. Ohmae, Kenichi (1995) The End of Nation State, A Harvard Business Re­view Book, Cam­bridge, MA.

21. The Heckscher-Ohlin theory (H-O-theory or -model) has its historical roots in the phenomenal success of the Nordic countries from the 1880s to the 1980s. • The relocation of industrial activities from the U.S. and the EU to China and India is actually a manifestation of the H-O-theory. The huge growth of FDIs in China and India is partly the result of the neoliberal policy that these countries apply in international trade. China and India have left behind the Marxian labor theory of value.They have successfully combined the state control in certain key areas with the price mechanism of global markets. • Their industrial policies include an ideological mission of H-O-advantage. China, India and also many other developing countries follow the maximal mobilization of a nation’s resources to provide profitable sites for MNCs’ FDIs in the commodity production. • This is the mixed economy policy model that the Nordic countries applied after the war to move from the factor-driven economies to the innovation-driven ones, like in Porter’s model. A mixed economy combines the private firms of capitalism and a degree of state control, as in at least partly state-owned industries and the state’s monopoly in certain welfare services. Ohlin, Bertel (1933) Interregional and International Trade Harvard University Press.

22. The H-O-model is relevant to the low-tech production that is local of its nature, not to the high-tech production that is global, R&D-oriented and Schumpterian of its nature. • The H-O-model is generally accepted as a theory of trade. Empirical research has produced a number of results that do not match the expectations of the model. In 1954, Wassily Leontief, a Nobel-prize winner, attempted to test the model in the U.S. in the early years after the Second World War and found that a capital-abundant country exported labor-intensive and imported capital-intensive commodities. This so-called Leontief's paradox is the reason why some economists have dismissed the H-O theory. • However, the problem is not the H-O theory as such, but the concept of capital. The U.S. has its advantage in highly skilled labor. This can be seen as human (or intellectual) capital. Using this definition, the exports of the U.S. is human capital abundant, not particularly unskilled labor abundant. During the wartime the U.S economy oriented towards innovations and human capital, which is the historical reason for the Leontief's paradox. Later, the U.S. technology and knowledge were delivered all over the world.

23. Staffan Burenstam Linder, a Swedish economist who tried to provide a possible resolution to the Leontief's paradox. • The H-O- patterns of international trade are factor-driven. A country with high levels of capital is expected to produce capital-intensive goods, while those with an abundance of labor are expected to produce labor intensive goods. Staffan Linder hypothesized that demand plays a more important role than comparative advantage in trade • In his model, a pattern of trade is determined by the aggregated preferences for goods within a country. Demand-based international trade arises from consumers’ taste of variety. This aggregate taste for variety arises because different individuals have a different specification of their ideal variety. • Countries with similar preferences are expected to have the same structures of industries. For instance, the U.S. and Germany have both large automotive industries that can be explained by a significant demand for cars in both countries. In terms of Chamberlin, there are a lot of monopoly elements in international trade, since both countries trade differentiated cars. Burenstam Linder, Staffan (1961) An Essay on Trade and Transformation, Almqvist & Wickley, Stockholm.

24. The collapse of the cluster-based innovation systems that has been the major competitive advantage of both the EU and the U.S. • Ohmae’s book The End of the Nation State refers the losses of Western countries. From the western welfare state’s point of view, the massive relocation of industrial production to China and India has been a hazard. When MNCs relocate their manufacturing, they maintain ownership, but the home-base regions of the clusters loose their proximity advantages, the learning ability and, even the innovativeness. The huge growth of global trade, especially intra-industry trade, can provide compensations the losses of industrial production. Proximity reduces cognitive distance, since actors have a common reference frame or a shared technical code (Nooteboom, B. (1999): Innovation, Learning and Industrial Organisation, Cambridge Journal of Economics, 2, pp. 127-150). An exellent analysis of Danish regional clusters (Andersen, Poul Houman (2006) Regional Clusters in a Global World: Production Relocation, Innovation, and Industrial Decline, California Management Review, pp. 101-122.) • In the EU the four factors to be counted are: • The widening of the EU to the East and Central European countries that, perhaps, increase the EU’s economic-political power in the mid of the global Triad. • Socio-cultural stability and tolerance are something unique in the EU. • The civil crises management initiative is an example of EU’s political role globally. • EU’s infrastructure, transport connections and flexibility provide good options to any of global actors in the sea, air and information logistics to operate.

25. The U.S. is worried about its role. Gary Hamel has claimed that the hollowing-out process of the US industrial firms. • Hamel believes that a short-term strategic horizon may mislead firms to cut down their jobs to better their competitiveness on the expense of developing the people-embodied skills needed for a long-term product leadership. A short-term relocation of activities may hide the costs of outsourcing and raise barriers to the future technology leadership. • The US senate, which even in normal circumstances is ready to intervene in the imbalances of the international trade, has reacted to the hollowing-out process of US industry by working on bills to restrict the U.S. government contractors from outsourcing work overseas. • From economic theory point of view, Paul Krugmanclaims that nation states are not the subjects of global competition. Hamel, Gary (1991) Collaborate to Compete, Strategic Management Journal, Special Issue. The argument is that the relocation is a process of knowledge codification, where knowledge becomes increasingly ripe for imitation by competitors in China and India (Reich, R. E. & Mankin, E. D. (1986) Joint Ventures with Japan give away our Future, Harvard Business Review, Sep-Oct). Krugman, Paul (1994) Competitiveness: A Dangerous Obsession, Foreign Affairs.

26. Substituting labor with capital and technology, along with shifting production to lower-cost regions has resulted in waves of firm downsizing in the EU, the US and Japan • Finland, Ireland and Sweden are the most specialized in the ICT, with respect the share of ICT in the manufacturing exports, in gross value added, and in R&D. In the 90s, these countries got advantages of the divergence, the tendency of an industry to grow where it is already over-represented, and concentration, clustering the ICT production in a certain places. Changes in the ICT are radical as the case Finland demonstrates. • The impact of relocation of industrial activities out of the home-base is called Wintelism. A parallel trend is the decreasing importance of mastering manufacturing. The formerly critical skills of the regional cluster become commodities, available by contract from producers that try to relocate the production capacity globally. Baily, Martin, Bartelsman, Eric and Haltiwanger, John (1996) Downsizing and Productivity Growth: Myth or Reality? Small Business Economics, 8(4), pp. 259-278. Hart, Jeffrey. A. & Kim, Sangbae (2002): Explaining the Resurgence of U.S. Competitiveness: The Rise of Wintelism, The Information Society, 18, pp. 1-12

27. The WTO TRIPS Agreement (Trade-Related Aspects of Intellectual Property Rights) • The Uruguay Round negotiations resulted in the TRIPS Agreement which came into effect with the WTO on 1 January 1995. • The WTO TRIPS Agreement established standards of protection as well as rules on enforcement, and most significantly, brought the IPR regimes of WTO member countries under the jurisdiction of the new dispute settlement system of the WTO. • The TRIPS is an institutional innovation. It introduces IPRs into the GATT framework and thereby shifts the emphasis of procedural uniformity, as promoted by the WIPO, to minimum standards of substantive protection. • The World Intellectual Property Organisation (WIPO) was established in the 1970s to govern these Conventions. WIPOs reliance on voluntary accession of countries, made it an unsuitable vehicle for achieving and policing minimum standards. The WIPO treaties facilitate international harmonization, but not protection for IPRs. • Property rights matter because they influence a firm’s competitive environment. The major part of property rights is assigned to firms, MNCs. Therefore, costs and rewards associated with the use of property rights and, notably the use of IPRs do accrue to the firms. Machlup, Fritz and Penrose, Edith (1950) The Patent Controversy in the Nineteenth Century, Journal of Economic History, X (1), May, pp. 1-29. 

28. The intellectual property rights have a respectable connotation of property, instead of the more unpleasant monopoly privilege. • The TRIPS along with the trend toward modularization and standardization in industrial commodities makes FDI much easier. Global business operations are, however, risky. FDIs can be a green field investment, establishing a foreign affiliate starting new production facilities, or merger and acquisition operation that aims at acquiring control of existing entities. • To be local in the globalizing economy, FDIs are necessary. NMCs seem to dominate even industrial services, a rapidly growing market segment, because NMCs have their global geographical reach. • The growth of total capital invested into developing economies has been huge during the three decades of globalization. One estimation is from $104 billion in 1980 to $472 billion in 2005 • FDI is an important source of external resources and a significant part of capital formation, despite that their share in global distribution of FDI is declining. The majority of FDI still goes to the well developed countries, where wages are high relative to those in developing countries. We are in the midst of a global reallocation of production activities.

29. China and India were the star performers in aggregate GDP growth since the 1980s • The rush of Western firms to access these countries, with their enormous domestic market, seems to continue. What is surprising is the speed by which the local firms, especially Chinese firms, have developed their technologies and positioned themselves as potential competitors to producers in the EU and the U.S. Chinese firms have succeeded to turn the state control to their advantage by beating MNCs their home markets. Now these firms are launching their first export products to beat western MNCs globally. • Ming Zeng and Peter Williamson have studied the strategies and performance of 50 Chinese companies, warn against such complacency, saying: “Multinational executives who do not perceive China's state-owned and privately-held companies as potential competitors have missed the rise of the new breed of Chinese companies that have already succeeded in capturing some foreign markets.” Zeng, Ming, and Williamson, Peter (2003) The hidden dragons, Harvard Business Review, Vol. 81 No. 10, October, pp.92-9). Andersen, Poul Houman (2005) In the shadow of the Dragon and the Tiger: Towards a new understanding of production relocation, innovation and industrial decline, 1. Draft. To be presented at IKE seminar, January 7, 2005, www.business.aau.dk/ike/upcoming/dragon.pdf

30. Scientific Knowledge: The TRIPS is a catalyst for the knowledge economy. The U.S. has innovated new kinds of innovative policies • Scientific knowledge as a commercial commodity is the most profound characteristic of globalization. Universities all over the world are actively producing commercial knowledge for business firms, following Stanford University’s role model in Silicon Valley. The foundation for innovation university model is to be found in two institutional innovations in the U.S.: • The Bay-Dole Act, enacted in 1981, provided universities the first-right to commercialize patents, and, if they fail, the Federal Government retains the ownership of patents and then can grant non-exclusive licenses to interested third parties. • The institutional innovation was the liberalization of the Federal antitrust laws to allow collaborating research projects between firms in the same industry. • New business models, which focus on knowledge rather than technology, are appearing, with an explicit focus on the development of network positions, knowledge management and global configuration of activities. • Mega-science themes, like the human genome project or nanotechnology, are global in their basic nature as such since they can only be addressed on a global scale. Both will change the world more than could be expected.

31. Global Competition in Science and Technology in the US: A Strong National Response Required • Innovation is a key to economic competitiveness and the technological breakthroughs that improve our lives. The Federal Government established the basis for the Nation’s land grant institutions through the Morrill Acts in the second half of the 19th century. During World War II, the wartime success of the partnership between universities and the Federal Government through the Office of Scientific Research and Development (OSRD) led to a proposal—requested by the President—from the head of OSRD for public funding for research, specifically basic research, in academic institutions and research institutes. • Such funding would encourage the creation of knowledge and employ science and engineering (S&E) for discovery and innovation—and thereby expand national economic growth, increase employment, and improve the quality of life. This proposal ultimately led to the creation of the National Science Foundation (NSF). • Through its support of entities that fund basic research, the U.S. Government helps underwrite our national infrastructure for science and engineering R&D and thereby the global preeminence of the U.S. in S&E innovation. Over time, the Federal Government support for R&D, and the related important efforts of industry, have grown into a complex and changing web. Given the impacts on the national innovation infrastructure of changes in investment patterns, it is imperative that patterns and trends of R&D investments be monitored.

32. The US research and development policy: A Declining National Commitment • In 2006 the total expenditure for R&D conducted in the U.S. was about $340B in current dollars. Of this total, basic research accounts for about 18% ($62B), applied research about 22% ($75B), and development about 60% ($204B). • The Federal Government is the second largest source of R&D funding (28%) following industry that funds two-thirds of US R&D. • Federal funding is the primary source of basic research support in the U.S. (over 59% in 2006), of which about 56% is carried out by academic institutions. U.S. basic research is also funded by foundations (about 10%), universities and colleges (about 10%), and state and local governments (about 3.5% through funding of academic basic research). • U.S. industry and the Federal Government are the primary pillars of financial support for the U.S. R&D. The National Science Board (Board) observes with concern the indicators of stagnation, and even decline in some discipline areas, in support for U.S. R&D, and especially basic research. • Federal obligations for academic research (both basic and applied) will increase for physical sciences research in future years. A major decline has seen in the current support for National Institutes of Health (NIH). www.nsf.gov/statistics/nsb0803/

33. International Competitiveness of the U.S. in Science and Technology • A review of quantitative indicators of the state of U.S. science and engineering in the new Science and Engineering Indicators 2008 provides some measure of U.S. international standing in R&D. T • he total 2006 R&D in the U.S. (about $340B) comprised about 2.6% of the Nation’s gross domestic product (GDP). The ratio of R&D to GDP is a widely used measure of an economy’s R&D intensity. From a high of about 2.9% of GDP in the early 1960s, the Nation’s R&D expenditures have hovered around 2.5% of GDP in the last decades. With 2.6% of its GDP devoted to R&D, the U.S. ranks seventh among OECD] countries, and second among G-7 countries (as it has for the last more than a decade at least). U.S. funding for R&D has exceeded 50% of the total G-7 nations’ R&D since 1997. In 2002 (the latest global data available), the U.S. expenditures for R&D were one third of the world-wide total R&D (over $800B in current dollars). • Countries can be compared over time with respect to contributions to knowledge and innovation using two indicators of research outcomes: (1) patents, as a measure of a nation’s inventiveness and (2) publications by authors from the respective nations in peer reviewed journals, as a measure of cutting edge S&E capabilities.

34. Patents • The share of patent applications in the U.S. patent office filed by inventors residing in the U.S. dropped from 55% in 1996 to 53% in 2005. The percentage drop was largely caused by the increasing filings by Asian inventors. Inventions for which patent protection is sought in the world’s three largest markets—the U.S., the EU, Japan—are called "triadic patent families." The U.S. has been the leading source of triadic filings (about 37% of the world share) since 1989, when it surpassed the EU, and its share has continued to increase. The U.S. position in patent filings and in triadic patents suggests sustained U.S. leadership for inventions. • Companies that innovate might not always choose to secure every innovation through patenting. Some innovations can be retained as trade secrets. Growing, maintaining and defending a patent portfolio involves costs, so that companies must evaluate the marginal benefits of individual patent filings. On the other hand, cross-licensing of patents can be competitively beneficial for companies, as can the revenue received from licensing or sale of patents. Thus, motivations for patent filings, and therefore the significance of declines in the share of U.S. filings, are not well understood.

35. Publications • Basic research articles published in peer-reviewed journals by authors from U.S. private industry peaked in 1995 and declined by 30% between 1995 and 2005 as industry research, and therefore publications, tended to shift away from basic research. Five broad fields—biological science, geosciences, chemistry, physics, and medical sciences—account for 95% of the industry basic research literature. The drop in physics publications was particularly dramatic: decreasing from nearly 1,000 publications in 1988 to 300 in 2005. • The decline in physics publications by U.S. industry is likely reflected in the observed drop in share of highly influential S&E articles published by U.S. authors in peer reviewed journals: The U.S. has now dropped from first to second rank in physics over the 12-year period from 1992 to 2003. The U.S. retained the first rank in all other major fields in 2003, but overall lost share of highly influential articles, dropping from 63% to 58%. Other fields where the U.S. declined to near parity with the EU-15 in recent years are biology and chemistry, also traditional focus areas for industrial basic research publications. • This most likely reflects, in part, the decline in U.S. industry authors’ publications, and flat (or decreasing as in the case of physics) industry support for its own basic research. In the field of engineering/technology, although the U.S. lost share while the EU-15 gained, the decline in U.S. share more importantly reflects the rapid rise in share by the East Asia-4 (comprising China, South Korea, Singapore, and Taiwan). U.S. annual growth in all S&E article publications in peer reviewed journals also slowed from 3.8% over the period from 1988 to 1992 to 0.6% from 1992 to 2003. Although the rate of growth also declined for the EU-15 and other S&E publishing centers, all exceeded the U.S. growth rate during both periods.

36. Intellectual Property and Industrial Innovation • Patents and publications do not necessarily equate to innovation and thus do not reflect the totality of industrial innovation. In global, competitive, high technology industries, some innovations might be more cost effectively protected by means other than patenting. In addition, research and/or commercial priorities might direct limited resources towards further advances in research or to addressing how to apply the results of the innovation rather than publishing articles. • The growing competitiveness in the global environment is resulting in new business models such that the impact of innovations might not be captured in current international trade metrics. Companies might innovate and create intellectual capital in one country that is then utilized in designing and developing products, services, applications, etc. in that country or another. • The complete process from creation of intellectual capital and high-tech design through to fabrication and distribution of products, services and applications can be performed across many countries in a global supply chain that can result in cost-effective products for consumers. Although the transfer of a physical product across a border may be recorded in such a process, if no intellectual property licensing occurs, the value of the intellectual capital may not be captured by the current global trade metrics.

37. International trade: Big players dominate • International trade in goods and services was as a whole $10.159 billion in 2005. It is 10-times more than in the 1960s. • Germany maintains the top of the list with $971 billion. The US is second with $904 billion. China’s export earning is $762 billion with 28 % growth, surpassing Japan’s export of $596 billion. India earned $90 billion with 19 % growth. • The top list dominates shares in world trade of commercial services which $2,415 billion in 2005, and 11 % as the annual growth. • The dominant player of world trade is Europe that represents 43 % of both imports and exports. The second one is Asia with 25 % of imports and 27 % of exports. The third is North America with 22 % of imports and 14 % of exports. Africa is lagging behind with 3 % imports and exports. http://www.wto.org/English/res_e/statis_e/its2006_e/its06_byregion_e.htm

38. International trade: Big competitive edges in the sustainable development • Due to economic and social reforms, China and India are sustaining annual GDP growth rates exceeding 10% and 8%, respectively. Robust GDP growth is creating seemingly insatiable energy demand in both of these countries. Most of global citizens become aware of the threatening situation when the former U.S. Vice President Al Gore calls for the U.S. to reduce its greenhouse gas emissions. • The big competitive edges are related to the sustainable development. An example is German where renewable energies have achieved a share of 14.2% of the country's gross electricity consumption in 2007. The Revision of the Renewable Energy Sources Act fasters the progress in the near future. Their share of Germany’s total energy consumption rose to 8.5%. Turnover from the installation and operation of plants in Germany rose by 10% to EUR 24.6 billion. This was associated with further growth in the number of jobs in the sector, which employs about 249,000 people. Taken altogether, renewable energies supplied 222 terawatt hours (TWh) of energy in the electricity, heating and fuel sectors. http://www.energy-enviro.fi/index.php?PAGE=1598&PRINTAREA=textarea [3]http://www.energy-enviro.fi/index.php?PAGE=1598&PRINTAREA=textarea

39. The sustainable development: The World Energy Outlook report 2007 by the International Energy Agency (the IEA • The World Energy Outlook report 2007 by the International Energy Agency (the IEA) projects that India’s and China’s growth of energy demand until 2030 will be 45% of total growth. If China’s and India’s per capita oil use will reach the same level as the U.S., this would fully deplete the world's remaining proven oil reserves in just 15 years. • This is the main reason why the IEA warns that the price of a barrel of oil could rise to $159 by 2030 due to high growth in demand. Long term crude oil price increases reflect a long term supply/demand imbalance. According to a US Department of Energy (the DOE) report, overall worldwide demand for electricity is expected to expand 2-3% annually and reach 26.0 billion MWh by 2025. • The rapid depletion of conventional energy sources such as crude oil, natural gas and coal will result in a shortage of these fuels for electricity generation. The International Energy Agency (IEA) warns that rising global demand could create a supply crunch as early as 2015. According to the IEA, current global oil production is 85 million barrels a day. • The IEA predicts output will grow to 118 million barrels by 2030, but this level of production is not enough to meet rising demand.

40. The net oil export capacity that is the very lifeblood of the world industrial economy is draining away. • Gasoline is a complex mixture of over 500 hydrocarbons of which many are carcinogenic. Two ingredients of gasoline (benzene and butadiene) are topped list of the most dangerous airborne carcinogens. • Petrochemicals produced from oil are also used to make computers, air conditioners, home cleaning products, and clothes. This is 5% of the oil use. The vast majority of oil is used as gasoline. Today, crude oil use in traffic has reached a point of diminishing returns. Crude oil dominates fueling the transportation, although the US has 2% of crude oil reserves. 83% of the world’s proven oil reserves are in the Middle East. • Proven oil reserves are shrinking. There have been no new major oil discoveries to replace the Middle East oil. In four decades, the U.S. crude oil imports from domestic use have risen from 0% to 60%. The top five net oil exporting countries (Saudi Arabia, Russia, Norway, Iran and United Arab Emirates), collectively accounting for about half of current world net oil exports, in aggregate are going to decline in net oil exports. Hall, J. V., V. Brajer, et al (2004) Risk of esophageal, ovarian, testicular, kidney and bladder. cancers and leukemia among Finnish workers exposed to diesel or gasoline engine, International Journal Cancer, 111 (2): 286-92. www.opencongress.org/bill/110-h2701/show www.secureenergy.org/files/files/936_Recommendations_2008.pdf www.niaslinc.dk/gateway_to_asia/nordic_webpublications/x506037311.pdf www.financialsense.com/fsu/editorials/brown/2008/0108.html

41. According to global temperature figures for 2007, the top 11 warmest years all occurred in the last 13 years. The global climate change can be more serious as expected. • Christopher Field, the leading member of the Nobel Prize-winning Inter-governmental Panel on Climate Change, estimated that the amount of greenhouse gases in the atmosphere have increased by 3.5% in the 2000s instead increasing by 1% in the 1990s. Given the greater-than 80% reductions in greenhouse emissions we need to achieve in the coming few decades, the situation is confusing, since as a part of the global energy mix, coal is predicted to play a big role until 2030. The IEA forecasts coal to rocket in demand by 73% from 2005 to 2030. Coal is the most carbon intensive way of generating electricity. The global warming is out of control. There is a risk of huge methane emissions from the subarctic tundra. This is a consequence of high methane production rates even at low temperatures. Russia is holding 50% of the northern hemisphere’s terrestrial carbon. The massive forest fires in Siberia in 2003 are said to have released as much greenhouse gas into the atmosphere as the total EU reduction commitment under the Kyoto protocol. • The risk is that 1.000 billion tons of greenhouse gases will be released from the arctic, subarctic regions, boreal/ semi-tundra larch forests, etc. mainly from Siberia[6]. The World Meteorological Organization (WMO), Michel Jarraud, at the Conference of the Parties (COP) in Bali. Eurekalert - December 13, 2007. www.democracynow.org/2009/2/26/member_of_un_environment_panel_warns Heyer, Jürgen, Berger, Ursula, Leontevich Kuzin, Ivan, Nikolaevich Yakovlev, Oleg (2002) Methane emissions from different ecosystem structures of the subarctic tundra in Western Siberia during midsummer and during the thawing period, Publication: Tellus B, Vol. 54, issue 3, p.231.

42. In the global economy, the leading industrial and industrializing countries are obliged to decrease per capita oil use. The only real options are natural gas and biofuels • Consumption of natural gas worldwide will increase 63% until 2030. Natural gas is the key fuel in the electric power and industrial sectors. Natural gas burns more cleanly than coal or petroleum products . The national plans to reduce carbon dioxide emissions encourage the use of natural gas. Almost 3/4 of the world’s natural gas reserves are located in the Middle East and Eurasia. Russia owns 27.2% of the total, 1,680 trillion cubic feet of the world total 6,183. • Russia’s extensive pipeline network reaches into Europe and in the near future China and South Korea. In addition, Russia is beginning to enter LNG markets . It has traded pipeline gas for Atlantic LNG cargos, has plans to develop LNG export facilities to serve the Atlantic market, and soon will start exporting LNG from its Pacific coast. In 2005, 15 percent of the LNG exports from the region went to North America and Europe and 85% to Asia. Despite the increase in natural gas consumption, regional reserves-to-production ratios are substantial. • Worldwide, the reserves-to-production ratio is estimated at 65 years. The leading regions in the ratio are: Middle East 100 years, Africa 88 years, Russia 80 years, and Central and South America 52 years. www.eia.doe.gov/oiaf/ieo/pdf/nat_gas.pdf BP Statistical Review of World Energy 2006 (London, UK, June 2006), p. 22.

43. The BIO's (Biotechnology Industry Organization) vice president Brent Erickson says that "Such a new energy infrastructure has not occurred in more than 100 years. We are at the point where we were in the 1850s when kerosene was first distilled and began to replace whale oil. This technology will be coming so fast that what we say today won't be true in two years." Chemical & Engineering News - January 07, 2007. • The EU’s Intelligent Energy Europe program set out an ambitious growth of biofuels until 2020. The EU has established a bioethanol blend mandate for its member states of 5.75% by 2010, and 10% of all vehicle fuels by 2020. Brazil, the world’s biggest exporter of ethanol, requires up to a 25% blend of ethanol with all gasoline sold. The U.S. Energy Bill provides $170 billion in technology, infrastructure, and biofuel refineries. The alcohol constitutes about 10% of the volume of the biodiesel. Among the most land-efficient and energy-efficient methods of producing alcohol is from hydrolysis and fermentation of plant cellulose. • At heart, biofuels are a form of solar energy, as plants use photosynthesis to convert solar energy into chemical energy stored in the form of oils, carbohydrates, proteins, etc. A photosynthetically efficient plant is algae. The yields of oil from algae are higher than those for traditional oilseeds, and algae can grow in places away from the farmlands and forests, thus minimizing the damages caused to the food chain. Algae can be grown next to power-plant where they digest the pollutants. PetroSun, Inc. constructs and operates a biodiesel refinery near Coolidge, Arizona. The feedstock for the refinery will be algal oil produced by PetroSun BioFuels at algae farms to be located in Arizona. The refinery will have a capacity of thirty million gallons and will produce 100% renewable biodiesel. PetroSun BioFuels will process the residual algae biomass into ethanol. MarketWire - January 10, 2007.

44. Hydrogen as a fuel has received widespread attention in the media. There are problems with using hydrogen as a fuel. The obvious is that hydrogen gas is explosive with low energy density. • Hydrogen's volumetric energy density is 7% of that of biodiesel. There are two main options for producing hydrogen, generating it from water, and extracting it from other fuels. Currently, most hydrogen used industrially is extracted from natural gas. The option of producing it from biomass is not realistic. Biomass can be converted to liquid fuels more efficiently, yielding a fuel with far higher energy density, and that can work in existing vehicles. Russia’s big natural gas, oil and coal resources provide a basement for hydrogen production. Billions of cubic meters of associated gas of oil and gas production are flared off every year. Using innovative technologies developed by the Kurchatov Institute, the associated gas can reformed into hydrogen, which could be delivered via natural gas pipelines to the EU hydrogen markets. For hydrogen vehicles, manufacturers have production stage vehicles ready. The problem is to scale hydrogen fuel production and distribution systems. The hydrogen needs to be compressed to high pressures for storage in fuel tanks. The Kurchatov Institute is Russia's leading research institution in the field of nuclear energy. www.nti.org/db/nisprofs/russia/reactor/research/with/kurchato.htm There are programs going on in Russia for clean energy production including hydrogen generation and storage, fuel cells and hydrogen engines, in which companies like Gazprom are participating. With a single hydrogen fuel pump costing roughly $1 million, installing just one at each of the 176,000 fuel stations across the US would cost $176 billion - a cost that can be avoided with liquid biofuels that can use our current infrastructure. www.changethis.com/9.Biodiesel/download

45. While a hydrogen vehicle uses electricity to electrolyze water to get hydrogen for fuel, an electric vehicle uses electricity to charge batteries. Battery charging systems are 90% efficient, compared to the 70% efficiency for electrolysis . Figure 2: Revolution in car technology (Matti Roine/ The VTT)

46. A distinction can be made between sustainable agriculture (e.g. organic agriculture) and intensive farming (e.g. industrial agriculture) A distinction can be made between sustainable agriculture (e.g. organic agriculture) and intensive farming (e.g. industrial agriculture) • In the past decades, green revolution popularized the use of conventional hybridization to create high-yielding varieties. In the U.S., industrial agriculture food costs attributed to processing, distribution, and marketing have risen while the costs attributed to farming have declined. Market concentration has increased in the sector. The top 20 food manufacturers account for half the food-processing value and top 6 supermarkets had 50% of sales. • Agriculture represents 70% of freshwater use worldwide. There is a trend towards the big-scale farming, relying on agricultural chemicals (fertilizers and pesticides), mechanization, and plant breeding (hybrids and GMO's. For example, average yields of corn (maize) in the USA have increased from around 2.5 tons per hectare (t/ha) (40 bushels per acre) in 1900 to about 9.4 t/ha (150 bushels per acre) in 2001. www.knowledgerush.com/kr/encyclopedia/Agriculture The U.S. Food Marketing System, 2002--AER-811 www.ers.usda.gov/publications/aer811/aer811.pdf Genetically Modified Organisms (GMO) are results of genetic engineering techniques generally known as recombinant DNA technology. www.answers.com/topic/genetically-modified-organism.

47. Genetic engineering has expanded the genes available to breeders to utilize in creating desired germ lines for new crops • Genetic engineers will develop transgenic plants which would allow for drainage, conservation, etc. and increasing yields while requiring fewer fossil fuel derived inputs than conventional crops. However, genetic engineering of plants are questioned by some ecologists and economists concerned with GMO practices such as terminator seeds and the patent protection given to companies that develop genetic engineering innovations. Companies that have IPRs of their seeds can dictate terms and conditions of their patented product since few seed companies control global seed sales. • GMO seeds legally bind farmers to change their seed saving practices to buying new seed every year.Locally adapted seeds are an essential hertitage. Introducing GMOs and hybridized commercial seed to an area brings the risk of cross-pollination with local land races. A global treaty, the BioSafety Protocol, regulates the trade of GMOs. The EU requires GMO foods to be labeled, whereas the US does not require labeling of GMO foods. www.infoagrar.ch/ipr-symposium/documents/paper_mariano.pdf Vandana Shiva argues that these companies are guilty of biopiracy by patenting life and exploiting organisms for profit www.panna.org/docsGe/docsGe_030922.pdf

48. While most of policy leaders support greater use of ethanol, some criticize biofuels of creating competition between the world's supermarkets and its service stations • Developments for global agriculture reflect continued high crude oil prices and the strong demand for biofuels, particularly in the U.S. and the EU. In the U.S., there is a boom in corn-based ethanol production, which affects production, use, and prices of farm commodities throughout the sector. Expansion of biodiesel use in the EU raises demand for vegetable oils in global markets. Steady domestic and international economic growth in the projections supports gains in consumption, trade, and prices. The U.S. Department of Energy has set a conservative goal of replacing 60 billion gallons of petroleum-based gasoline (30 percent of current usage) with biofuels by 2030. Further, the Department of Energy and Department of Agriculture envision replacing petroleum with biomass feedstocks in 25 percent of chemical production by that same year. • Ethanol's critics argue that it not possible to produce enough biofuel from agricultural commodities to break our addiction to oil without impacting the availability of food

49. The U.S., agricultural productivity has grown steadily, at an annual rate of 1.8% over the past 35 years. Therefore, the USDA concludes that the U.S. farm sector is strong enough to produce a sufficient and affordable supply of food well into the future

50. Climate change has the potential to affect agriculture through changes in temperature. Agriculture can mitigate global warming. • Agriculture imposes external costs upon society through pesticides, nutrient runoff, excessive water usage, and assorted other problems. Two studies concluded that more should be done to internalize external costs, and neither included subsidies in their analysis, but noted that subsidies also influence the cost of agriculture to society. Pesticide is 2.5 million tons annually worldwide. A major petroleum issue in agriculture is the effect of petroleum supplies will have on fertilizer production. • One example of the chain reactions which could be caused by peak oil issues involves the problems caused by farmers raising crops such as corn (maize) for non-food use in an effort to help mitigate peak oil. When oil production becomes so scarce natural gas will be used as replacement, and hydrogen use in transportation increases, natural gas will become much more expensive. In 2007, higher incentives for farmers in the U.S. to grow biofuel crops combined with high oil prices are claimed to cause food shortages globally. www.absoluteastronomy.com/topics/Agriculture ]www.fromthewilderness.com/free/ww3/100303_eating_oil.html Some of the increase in CO2 in the atmosphere comes from the decomposition of organic matter in the soil, and much of the methane emitted into the atmosphere is due to the decomposition of organic matter in wet soils such as rice paddies. Wet soils also lose nitrogen through denitrification, releasing the greenhouse gas nitric oxide. www.absoluteastronomy.com/topics/Agriculture